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This Healthcare Juggernaut Is More Than Just a Retail Store

Most people only think of CVS Health (NYSE: CVS) as a drug store chain. The reality could not be more different. CVS has created a new, bold business model that unites its retail franchise and long standing pharmacy benefits management (PBM) unit, Caremark, with giant health insurer, Aetna. The company's goal is to create an integrated healthcare business. Improved operational efficiencies, technological innovation, and negotiating muscle should lead to lower patient costs and improved medical outcomes. In its own words, CVS's mission continues to be to "utilize our broad range of assets to provide a comprehensive set of health services with market leading affordability." As the COVID-19 pandemic slowly recedes, I think that the vast expanse of CVS Health's unique franchise will come back into focus and highlight its long term investment value. Here's why.

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How has CVS performed?

Merger integration and innovation takes time. It has been slightly over two years since the closing of the CVS and Aetna deal. The deal was slowed by the now settled legal fight over repealing portions or all of the Affordable Care Act, and recent pandemic-related issues affecting the entire healthcare industry. Yet, the combined entity has made significant strides in two key areas.

First, CVS has assumed a leadership role in diagnostic testing and vaccination. CVS, just ahead of chief competitor Walgreens Boots Alliance (NASDAQ: WBA), is at the forefront of battling the coronavirus pandemic. The company estimates it has performed over 70% of the tests done in a retail setting. Moreover it will play a critical and leading role in the administration of the coronavirus vaccine program. Given its nationwide reach, huge staff resources, and expertise in delivering standard flu vaccines, CVS will assume a great responsibility in the biggest vaccination effort in the nation's history.

Second, CVS has successfully launched several new healthcare products and services. An initiative called HealthHUB, which is now in over 400 of its 6,000 nationwide stores, provides medical, health and behavioral support services targeted to people with chronic diseases. The goal is to increase the installations to 1,500 by the end of 2021. This initiative will complement and integrate with its over 1,000 Minute Clinics that provide pharmacist and nurse practitioner assistance for routine medical issues that do not require primary doctor care.

Both efforts seek to lower patient (and by default Aetna's) expenses by keeping them out of hospital emergency rooms or expensive private practice physician groups for routine medical issues. Moreover, by making access to services and advice more widespread and convenient, CVS hopes to improve customers' overall health profile.

After its merger, the stock is attractive on many metrics

In a nutshell, because healthcare being a relatively recession resistant type business, CVS is a money machine. Its most recent guidance calls for cash flow from operations of $13 billion at the midpoint of its targeted range. Adjusted earnings are being guided to $7.40 per share at the midpoint. With its current share price around $75 that translates into a modest 10 times price-to-earnings (P/E) ratio, or less than half the current market multiple for the S&P 500. On its third quarter earnings conference call, CVS guided to relatively flat earnings in 2021, but is targeting "low teens" earnings-per-share growth starting in 2022. A 10% increase would produce $8.20 per share in earnings, which -- if you assign a still modest 12 times multiple -- equates to a share price of $98, 30% higher than current levels.

The story is even more appealing while you wait for earnings growth to resume, because the stock carries an attractive current dividend yield of 2.7%. CVS is also committed to reducing its considerable $60 billion debt load taken on for the Aetna acquisition. It currently maintains a somewhat high 5 times leverage ratio. The goal is to bring that down to a much more manageable ratio of just over 3 times by the end of 2022. Accomplishing that would free up excess cash flow to both potentially increase future dividend payments and reestablish the company's share buyback program. Both of those would be net positive for the future stock price.

It should be noted that CVS stock price has moved up considerably since the beginning of the year from the $67 range to its current level of $75 per share. That price level has proven to be a tough resistance point over the last two years. Waiting for a modest pullback on any overall market weakness might be a good short term strategy. Nevertheless, the long term outlook for the company's stock price is attractive.

New tailwinds at the company's back

Lastly, there was an important piece of news last week that highlighted the challenges facing new companies looking to upend the status quo of the large healthcare providers. Haven Healthcare, a joint venture between JP Morgan, Berkshire Hathaway, and Amazon announced it would be shutting down at the end of February. Launched with much fanfare two years ago, its strategy was to combine forces to to look for innovative ways to reduce costs in primary care, insurance coverage, and prescription drugs. It was one of the key motivations for CVS to acquire Aetna as it faced this heightened threat to its go it alone business model from three of the largest companies in the U.S. The announcement cited the extraordinary complexity and regulatory restraints to make major changes to the current healthcare landscape. This news further strengthens the investment case for CVS, as it shows how hard it is for competitors to successfully challenge its dominant market position.

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John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Bob von Halle owns shares of Walgreens Boots Alliance. The Motley Fool owns shares of and recommends Amazon and Berkshire Hathaway (B shares). The Motley Fool recommends CVS Health and recommends the following options: long January 2022 $1920 calls on Amazon, short January 2021 $200 puts on Berkshire Hathaway (B shares), short January 2022 $1940 calls on Amazon, and long January 2021 $200 calls on Berkshire Hathaway (B shares). The Motley Fool has a disclosure policy.


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